PFCB – GOING AGAINST MACRO

PFCB is facing easy comparisons in 3Q10 on many fronts. At the same time, trends are getting better at the Bistro, which should make for a strong third quarter.

I always look forward to hearing Co-CEO Bert Vivian’s candid and often colorful comments about reported quarterly results and current trends. Early on in the call, I could not get a read on his tone because although he said that business was improving at the Bistro, he also sounded less than confident in the company’s ability to achieve its current FY10 $2.00 EPS guidance, saying, “If our sales momentum continues, we stand a reasonable chance of achieving roughly $2 in earnings. If sales waffle in the back half of the year, we will not get there.”

His tone about current trends was less difficult to read, however, when he said he was feeling “fat, dumb and happy” about July trends. We later learned that July comps are running up 3% at the Bistro and +2% at Pei Wei. It is important to remember that PFCB is facing very easy comparisons in 3Q10 from a Bistro comp, margin and YOY earnings growth perspectives. In 3Q10, the Bistro is lapping a -8.5% comp number from 3Q09, but we know July of last year started out stronger with AWS down about 7% (AWS came in -9.2% for 3Q09). To that end, +3.0% in July implies stronger two-year average trends since the end of the second quarter, on top of the 130 bp sequential improvement realized at the Bistro during 2Q10.

Traffic turned positive at the Bistro during the first quarter and going into 2Q10, I was a little concerned about the company’s ability to maintain that momentum based on management’s plan to implement a 1%-2% price increase in May. Traffic continued to be positive during 2Q10, up 2.6% and held steady throughout the quarter.

The Bistro is seeing an improvement in trends across all of its dayparts. Specifically, management said that lunch business is stronger and that both weekday and weekend dinner trends are getting better. The company did not break out what is driving these better results, but partly attributed the stronger weekday lunch and dinner to increased business spending and the sequentially better weekend dinner traffic to increased social spending. Geographically, the company is experiencing stabilizing to slightly improved results in its California, Nevada and Arizona markets.

From a restaurant level margin standpoint, the Bistro continued to face some YOY pressure with margin declining nearly 100 bps. This was a huge improvement from 1Q10 when margin was down 300 bps. To recall, management attributed 180 bps of that decline to inefficiencies around the Happy Hour rollout. During 2Q10, margin improved largely as a result of better execution during Happy Hour; though the May price increase helped as well. Given that the Happy Hour margin did not normalize until late in 2Q10 (in June), restaurant-level margin should continue to improve during 3Q10 and turn positive, particularly if same-store sales trends continue to improve.

Comp trends continued to improve at Pei Wei in 2Q10 as well, with two-year average trends increasing about 150 bps from the prior quarter. It is concerning, however, that traffic fell off so significantly in May and June from April levels. The deceleration in traffic followed a 1% price increase in April; though management did not specifically attribute the slowdown to that price increase. The +2.0% comp at Pei Wei in July also points to a slight deceleration in two-year average trends since the end of 2Q10. Pei Wei is lapping a -0.7% comp from 3Q09, but like the Bistro, trends started out the quarter stronger with AWS -1% in July 2009 and -2% for the entire quarter.

As I already said, PFCB is facing easy comparisons in 3Q10 on many fronts. At the same time, trends are getting better at the Bistro, which should make for a strong third quarter. Given the softening consumer confidence metrics that have emerged recently, we will have to watch closely to see if the current sales momentum, which Vivian underscored as being essential for the $2.00 earnings target to be met, can be maintained. Relative to our restaurant sigma chart, shown below, PFCB should move up and to the right into the “nirvana” quadrant (positive same-store sales and growing YOY restaurant level margin) during the back half of the year after starting out the year in the “deep hole” quadrant (negative same-store sales and declining YOY restaurant level margin).

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